When it comes to the stock market, there is a fine line between gambling and investing. This may be more prevalent than ever in 2021. Sometimes it can be hard to tell the two apart. Both strategies attempt to make money, both involve a level of risk, and both require you to pick when you buy and when you sell. So when is it gambling and when is it investing? Deep down, I think we all know, but I’m going to do my best to differentiate the two.
Long-term vs. Short-term Focus
Investing: Investing is about being patient and seeking consistent returns over the long-term. The focus is on buying stocks that will perform best over a period of years. The investor wants a portfolio full of such stocks, knowing that the deck is stacked in his/her favor over time. Ups and downs in either direction in the stock itself or in the overall market shouldn’t change the strategy if the original thesis is still true.
Gambling: Gambling is more short-term. It seeks quicker, higher returns, but often encounters the opposite because of market fluctuations. Gambling is more of an in-and-out strategy. Because of the high number of trades, gambling will involve paying more in the form of bid/ask spreads and capital gains.
Buying Cash Flows vs. Price Appreciation
Investing: Investing is concerned with building cash flows. That centers the focus on companies that are projected to increase revenue and earnings over time. The stock may provide regular income through dividends or with capital appreciation through a higher stock price.
Gambling: Gambling is typically an aggressive play solely on price appreciation. The gambler is interested in selling at a higher price than he/she bought it at. This can lead to difficult decisions if the price quickly declines due to unfavorable market conditions.
Buying the Company vs. Betting on Trends
Investing: If you’re investing, you’re looking to buy low and sell high. For this reason, you might prefer to be a buyer in down markets or when a stock is out of favor. You may also buy a company with a high price that is expected to continue moving higher over a period of years. The focus is on the company.
Gambling: If you’re gambling, there’s a very good chance that you’re buying on trends. That means you might be a buyer in momentum markets or that you might be focused primarily on the hot stocks of the day. You’re buying on the current trend and betting that trend will continue in the same direction for long enough that you’ll be able to make money and move on.
The Importance of Fundamentals
Investing: Investing is concerned with valuation measures, such as the price-earnings-ratio (P/E). The investor will also be concerned with a company’s position in it’s industry and the competitiveness of it’s products and services. Investors will carefully consider a company’s management team.
Gambling: Gambling might involve largely ignoring fundamentals or not giving it proper analysis or thought.
Diversification as a Dividing Line
Investing: As investing is more concerned with fundamentals and the long-term, it typically involves diversification into various stock sectors and asset classes. An investor’s portfolio will usually contain a mix of stocks, bonds and cash. Investing is about building a mix of assets likely to grow over time with the risk tolerance of the investor taken into careful consideration.
Gambling: It’s not that a gambler won’t diversify at all, but more that they will be more likely to load up the portfolio with the best performers. It’s not uncommon to see 70% or 80% of a portfolio in a single sector. It’s a strategy that can payoff handsomely while the trend is in motion. But when it stops, the gambler is known to give it all back.
My advice: Keep the focus on long-term increasing future cash flows, quality companies, and emphasize the fundamentals. This is the base. Diversification and asset allocation should be appropriate with your risk tolerance and financial situation. Whether you are investing or gambling, make sure you identify which one you are participating in. Finally, and I may have mentioned it already, keep your sights long-term.
For a comprehensive review of your personal situation, always consult with your legal or tax advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
A diversified portfolio does not assure a profit or protect against loss in a declining market.